2014 remedial legislation including excepted financial arrangements, income derived from land, the mixed-use asset and loss grouping rules and more.

Excepted financial arrangements

Section EW 8 of the Income Tax Act 2007

Technical amendments have been made to section EW 8 of the Income Tax Act 2007 to clarify the application and effect of the financial arrangement rules to short-term agreements following an earlier change made by the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013.

Background

Before its amendment by the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013, section EW 8 allowed taxpayers to treat certain agreements and arrangements as falling within the scope of the financial arrangement rules. The election had an unintended consequence of allowing taxpayers to obtain a deduction under the financial arrangement rules for the purchase price connected with acquiring a short-term agreement for sale and purchase in situations when the purchase would be ordinarily classified as being on capital account (and therefore non-deductible). The Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013 amended section EW 8 so that the scope of the election was narrowed - refer to page 44 Tax Information Bulletin Vol 25, No 9 (October 2013).

In response to a submission on the bill from a life insurer, additional changes have been made to section EW 8 of the financial arrangement rules to clarify the treatment of short-term agreements for sale and purchase. The technical amendments made by the Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Act 2014 reverse elements of the earlier amendment made by the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013.

Key features

Specifically, the technical amendments:

  • repeal, from 27 September 2012,1 the changes to section EW 8 made by the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013; and
  • retrospectively restore, from 17 July 2013,2 the election permitted under section EW 8 of the Income Tax Act 2007, provided that the expenditure to be spread is on revenue account (that is, it does not rely on the election allowed by section EW 8 to deem the expenditure as on revenue account).

Taxpayers who applied the changes made by the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013 in a return of income or in connection with the determination of a binding ruling made by the Commissioner of Inland Revenue before 14 April 2014, and choose to continue with the tax position, are not affected by retrospective change.

Application date

The amendment has effect from 27 September 2012.

Spreading of income for income derived from land

Sections EI 7 and EI 8 of the Income Tax Act 2007

Sections EI 7 and EI 8 provide that certain income derived from land is spread forward evenly over the period of time referred to in those sections.

Transitional provisions apply to income derived before the 2015-16 income year if the taxpayer has previously chosen to apply either section EI 7 or section EI 8. The transitional provisions apply to that unallocated income as follows:

  • If the period of time referred to in those sections has not expired before the start of the 2015-16 income year, that unallocated income is spread evenly over the number of years remaining in that period, beginning with the 2015-16 income year.
  • If the period of time referred to in those sections has expired before the start of the 2015-16 income year, the unallocated income is allocated to the 2015-16 income year.

Background

Sections EI 7 and EI 8 of the Income Tax Act 2007 apply to taxpayers who derive income from land, either:

  • in the nature of fines, premiums or from a payment of goodwill on the grant of a lease (section EI 7); or
  • as a result of a compulsory disposal of land to the Crown (section EI 8).

Before self-assessment legislation was enacted in 2001, the corresponding provisions to sections EI 7 and EI 8 in the Income Tax Act 1994 allowed taxpayers to elect to spread the income forward. However, this spreading of income was required to follow the Commissioner's practice of spreading forward on an even basis over the number of years stated in the provisions. Following the enactment of self-assessment legislation, taxpayers had a choice to spread that income forward, although not necessarily on an even basis.

The amendments to sections EI 7 and EI 8 clarify that taxpayers may choose to spread the income forward, but the spreading must be on an even basis over the years referred to in both of those sections.

Application dates

The amendment applies to income derived in the 2015-16 income year and later income years. However, a transitional provision applies to income derived before the start of the 2015-16 income year if the taxpayer has previously chosen to apply either section EI 7 or section EI 8 for that income.

Detailed analysis

Sections EI 7 and EI 8 provide timing relief for taxpayers who derive income from land in certain circumstances. The provisions permit the taxpayers to spread the income forward evenly across the current and certain future income years instead of returning the income in the year it is derived. This relief applies to income derived either:

  • in the nature of fines, premiums or from a payment of goodwill on the grant of a lease (section EI 7, Income Tax Act 2007); or
  • from a compulsory disposal of land to the Crown (section EI 8, Income Tax Act 2007).

If the taxpayer chooses to allocate the income under either section EI 7 or section EI 8:

  • income derived from land for payments in the nature of fines, premiums or goodwill on the grant of a lease is allocated evenly over the income year the income is derived in and the five immediately succeeding income years; and
  • income derived from a compulsory disposal of land to the Crown is allocated evenly over the income year the income is derived in and the three immediately succeeding income years.

Transitional issues

Transitional provisions apply to income from land that has been derived:

  • before the 2015-16 income year; and
  • has not been fully allocated at the end of the 2014-15 income year.

In this circumstance, the taxpayer may elect to allocate the unallocated portion of the income evenly to income years from 2015-16 onward, ensuring that the income spread does not exceed the time period referred to in sections EI 7 or E I8.

However if the period of time referred to in the relevant provision has expired before the start of the 2015-16 income year, the taxpayer is required to allocate the unallocated portion of the income to the 2015-16 income year.

Example 1 Transitional effect

The taxpayer has chosen to spread the income derived in the 2011-12 income year from land for payments in the nature of fines, premiums or goodwill on the grant of a lease on an even basis. The policy intention is that this would result in all of that income being allocated evenly over the 2011-12 to 2016-17 income years.

The transitional rule provides that the amount of income derived in the 2011-12 income year that remains unallocated at the start of the 2015-16 income year is spread evenly over the 2015-16 and 2016-17 income years.

 

Example 2 Transitional effect

A taxpayer has derived income from a premium on the grant of a lease in the 2008-09 income year. Under section EI 7 it was arguable that the taxpayer could choose to allocate all or some of the income to an income year of choice, for example the 2018-19 income year. The policy intention is that the income should have been spread evenly over each of the 2008-09 to 2013-14 income years.

The transitional rule provides that the income derived in the 2008-09 income year that remains unallocated at the start of the 2015-16 income year is allocated fully to the 2015-16 income year. This is because the allocation of the income has already been deferred beyond the intended relief period, and therefore should be allocated to the 2015-16 income year.

Remedial amendments to the mixed-use asset rules

Sections DG 6, DG 9, DG 11, DG 16, DG 17 and DZ 21 of the Income Tax Act 2007

Remedial changes have been made to the mixed-use asset rules in subpart DG and section DZ 21 of the Income Tax Act 2007.

Background

The mixed-use asset rules were introduced as new subpart DG and related provisions by the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013. They are designed to prevent excess deductions being claimed where an asset is used partly to earn income and partly for private purposes - an example of which is a bach that is rented out when the owner is not using it.

The rules apply to land and improvements for the 2013-14 and later income years; and to certain boats and aircraft for the 2014-15 and later income years.

Since the rules were introduced, a number of technical issues have been identified. The following remedial amendments address some of those issues:

  • the specific associated persons rule for mixed-use assets in section DG 6 has been amended to ensure it applies as intended;
  • minor corrections have been made to several examples in the legislation;
  • the depreciation rollover relief provision that applies when a company distributes its mixed-use asset to one or more shareholders in the 2013-14 income year has been amended. This ensures that depreciation recovery income is ultimately crystallised if the shareholder sells the asset for more than its adjusted tax value (taking into account depreciation claimed by the company);
  • the "asset value" for land used in the apportionment formula and the quarantined expenditure provision has been modified to ensure it accurately reflects the true economic value to the taxpayer;
  • the apportionment formula in section DG 9 has been amended to deal with the use of an asset for capital purposes; and
  • the "asset income" definition in section DG 17 has been aligned with the definition of the same term in section DG 16.

These amendments are all consistent with the policy intent of the mixed-use asset rules.

Key features

Specific associated person rule for mixed-use assets

The concept of association is key to the mixed-use asset rules. Section DG 6 modifies the general associated persons definition. Specifically, section DG 6(a) deemed a shareholder who holds 5 percent or more of the shares in a company to be associated with that company. It was intended to remove this provision from the bill that introduced the mixed-use asset rules, however it was not removed before enactment. Accordingly, section DG 6(a) has been repealed with application for the 2013-14 and later income years. Section DG 6(b), which deems a shareholder to be associated with a company if the person's share in the company gives them a right to use a mixed-use asset owned by the company, will remain.

Corrections to legislative examples

Several examples in the earlier legislation contained minor errors. These are summarised below with the corrections made under the new legislation marked-up for emphasis.

Section Example and correction Why correction is needed
DG 11 Example
Holiday Home Ltd holds a holiday home with a rateable value of $200,000. The company has debt of $40,000, with associated interest expenditure of $4,000. Since the debt value is less than the asset value, all the interest expenditure must be apportioned (section DG 11(3)). Boat Ltd has a charter boat whose adjusted tax value cost is $60,000. The company has debt of $100,000, with associated interest expenditure of $10,000. Since the debt value is more than the asset value, the company must apportion interest expenditure of $6,000 (section DG 11(4)-(6)). The formula is $10,000 × ($60,000/$100,000) = $6,000.
Under section DG 11(8)(b), the appropriate "asset value" for property other than land is its adjusted tax value, not its cost.
DG 16 Example
David has a city apartment with a rateable value of $300,000. He rents out the apartment and also uses it privately. He receives market rate rental of $4,000 from non-associates, and $6,000 from associates. David's total allowable expenditure, under sections DG 7, DG 8 and DG 11, is $15,000. The income from associates is exempt under section CW 8B, and is ignored. David therefore has asset income of $4,000 and deductions of $15,000, giving rise to an excess of expenditure over income of $11,000. Since David's income from non-associates is less than 2% of the apartment's rateable value, the excess expenditure of $11,000 $5,000 is denied as a deduction. The amount denied may be allocated to a later income year under section DG 17.
The excess expenditure in this example is $11,000 not $5,000. The amendment also provides additional explanation of the calculations to assist readers.
DG 17 Example, continued from section DG 16
In the following income year, David derives $10,000 from renting his city apartment at market rates to a non-associate. David's total allowable expenditure, under sections DG 7, DG 8, and DG 11, is $8,000. He also has expenditure of $11,000 $5,000 quarantined from the previous income year. David is able to deduct $2,000 of that quarantined expenditure. The remaining $9,000 $3,000 continues to be quarantined and may be allowed as a deduction for a later income year.
Carry-through from correction of section DG 16 example.
DG 18 Example
Aircraft Ltd owns an aircraft to which the rules in this subpart apply; the income derived from the asset in the current year is less than 2% of the cost of the aircraft. The company has calculated an outstanding profit balance of $12,000 after the application of section DG 16. Aircraft is 100% owned by Parent Ltd, which has apportioned interest expenditure of $5,000 calculated under section DG 12. Parent has 2 equal shareholders, Alisa who has apportioned interest expenditure of $8,000, and Hamish who has apportioned interest expenditure of $1,000, both calculated under section DG 14. Parent must apply section DG 18 first, and is not required to quarantine any of its interest expenditure; the outstanding profit balance is reduced to $7,000 ($12,000 – $5,000). Alisa's and Hamish's share of the outstanding profit balance is $3,500 each ($7,000 $7,500 x 50%). Alisa must quarantine $4,500 of interest expenditure ($8,000 – $3,500); Hamish is not required to quarantine any interest expenditure.
Correction of numeric error.
DG 19 Example, continued from section DG 18
In the following income year, Aircraft Ltd has calculated an outstanding profit balance of $16,000 after the application of section DG 18. Section DG 19 does not apply to Parent Ltd or Hamish Alisa because they have no previously quarantined interest expenditure. However, the section does apply to Alisa Hamish because she he has $4,500 of quarantined interest expenditure from the previous year. Because Parent Ltd does not have any current year expenditure, Alisa's Hamish's current year apportioned interest expenditure is $7,000, calculated under section DG 14, and his share of the outstanding profit balance of Parent Ltd is $8,000 ($16,000 x 50%). Alisa's current year apportioned interest expenditure is $7,000, calculated under section DG 14. Alisa Hamish is allowed a deduction for all her current year expenditure and also a deduction for $1,000 of previously quarantined expenditure ($8,000 – $7,000). His Her remaining quarantined expenditure is $3,500 ($4,500 – $1,000).
Correction of names and additional clarification.
DZ 21 Example
On 31 March 2013, Boat Co has a boat with an acquisition cost of $85,000. on 31 March 2013 which The boat meets the various requirements set out in subpart DG. All the shares in Boat Co are owned by Michelle. The boat has a market value of $75,000, and an adjusted tax value of $55,000. Boat Co transfers the boat to Michelle without payment (which is treated as a dividend of $75,000). For depreciation purposes, Boat Co is treated as disposing of the boat for $55,000, and Michelle is treated as acquiring it for $55,000 $85,000, and having been allowed a deduction of $30,000 for depreciation loss in past income years.
Amendments to ensure the example is consistent with the change to section DZ 21.

Depreciation recovery income for assets transferred in the 2013-14 income year under section DZ 21

There is a one year transitional period (2013-14 income year) in which companies that own mixed-use assets can transfer those assets to their shareholders without triggering depreciation recovery income (this is referred to as "rollover relief"). The rollover relief provision is contained in section DZ 21.

Section DZ 21(2) previously treated the transfer as if it were a disposal and acquisition for an amount equal to the adjusted tax value of the asset on the date of the transfer. This meant that there was no deprecation recovery income to the company when it transferred the asset to its shareholder(s) because the consideration deemed to have been received was the same as the asset's adjusted tax value.

If the shareholder later sells the asset for more than its adjusted tax value, the policy intention is that depreciation recovery income will be crystallised at this point. To ensure this policy objective is achieved, amendments to section DZ 21 treat the shareholder as stepping into the shoes of the company for depreciation purposes - that is, by having:

  • acquired the asset on the date on which the company acquired it for an amount equal to the amount the company paid to acquire it;
  • used the asset for the purposes for which the company used it;
  • used the depreciation method used by the company in relation to the asset; and
  • been allowed a deduction for an amount of depreciation loss that the company has been allowed since the company's acquisition of the asset.

As well as including all depreciation deductions the company has previously been allowed in the depreciation recovery calculation, this amendment also ensures that any change in use or depreciation method by the shareholder is captured and the shareholder has the correct depreciation cost base.

Value for land and improvements

The value of land and improvements is relevant to the close company interest deduction quantification provision (section DG 11) and the expenditure quarantining provision (section DG 16).

As originally introduced, these provisions treated the value of land and improvements as the later of:

  • the most recent capital value or annual value (as set by the relevant local authority); or
  • its cost on acquisition (or market value, if the transaction involves an associated person).

In the case of leased land and multiple activities carried out on a single land title, using the capital value or annual value (as set by the relevant local authority) could overstate the asset's value for the purposes of subpart DG.

If, for example, a bach is on leased land, the capital value of the land is likely to overstate the value to the lessee as the lessee does not own the land. Therefore, a greater proportion of the interest deductions of a close company may be subject to apportionment under subpart DG than was intended and more apportioned expenditure will be quarantined under section DG 16 than was intended.

A similar valuation issue arises if, for example, two different taxpayers own separate baches situated on a single legal title. The capital value on the legal title will give the value for both buildings and the whole of the land area. Where the mixed-use activity is being carried on by only one of the owners, it would be very difficult for that owner to reach the quarantining threshold because of the presence of the two houses.

Another example is if a farmer sets up a house on a farm as a farmstay. The house is on the farm land, and is used to derive rental income, but is also used by the farmer's children and their friends when they come home. If the land value cannot be apportioned, the farmer will almost certainly have his farmstay expenditure quarantined under section DG 16 because it would be highly unlikely for the annual income from the farmstay to exceed 2 percent of the value of the total farm.

It is arguable that a leasehold estate is an asset separate from the freehold estate and therefore does not have a capital/annual value itself, which means that the relevant "asset value" is the price paid for the leasehold estate or the market value (if acquired from an associate).

Nevertheless, sections DG 11 and DG 16 have been clarified to ensure the "asset value" used for land and improvements is accurate for both leased land and land where two activities are carried out on a single title. This is achieved by defining the value of land and improvements for the purposes of sections DG 11 and DG 16 as:

  1. the later of either the land's most recent capital value or annual value as set by the relevant local authority, or its cost on acquisition or, if the transaction involves an associated person, its market value; or
  2. if the land or improvement to land is a leasehold estate in land, the market value of the leasehold estate which the person may establish by a valuation that is or has been made by a registered valuer no more than 3 years before the end of the income year; and
  3. if different activities are carried out on the land on a single certificate of title within the meaning of the Land Transfer Act 1952, the value applying under paragraph (a) or (b), as applicable, adjusted as follows:
    1. by multiplying the value by the percentage that the area of land that is the portion of the land used in relation to the asset to which this subpart applies bears to the total land area described in the certificate of title:
    2. by a valuation that is or has been made by a registered valuer no more than 3 years before the end of the income year, of the portion of land used in relation to the asset to which this subpart applies.
Example  

Bach Co Ltd owns a bach on leasehold land. The bach is subject to the mixed-use asset rules. The capital value of the land is $400,000, but a registered valuer has provided Bach Co Ltd with a valuation of the leasehold interest in the land of $300,000. The "debt value" for the purposes of section DG 11 is $400,000. Bach Co Ltd has annual interest expense of $20,000 and derives $7,500 of assessable income from the bach annually.

Under the mixed-use asset rules as introduced (and before the recent amendment), all of Bach Co Ltd's interest expenditure would be subject to apportionment under section DG 9. This is because the debt value is less than or equal to the asset value (section DG 11(3)).

In addition, Bach Co Ltd would be subject to the expenditure quarantining provision because the income derived ($7,500) is less than 2 percent of the value of the land.

Both outcomes are unintended, as the true economic value of the asset to Bach Co Ltd is $300,000, not $400,000.

Under the amended valuation rule, Bach Co Ltd can use $300,000 as the asset value. This means that only $15,000 of interest expenditure ($20,000 x $300,000/$400,000) is subject to apportionment under subpart DG  and the expenditure quarantining provision does not apply (because the income derived is more than 2 percent of the asset value).

Capital use of an asset

The apportionment formula in section DG 9 has been amended to deal with the situation when there is capital use of an asset, as well as income-earning use and private use.

The issue is explained by the following example.

A privately owned corporate group owns a plane that has the following use (per year):

  • private use (for example, the principal individual shareholder of the group flying overseas on holiday) - 20 days;
  • income-earning use (for example, the shareholder/manager flying overseas for business purposes where there is a direct nexus with income) - 20 days; and
  • capital use (for example, the shareholder/manager flying overseas to analyse potential capital acquisitions) - 20 days.

The plane is therefore used 1/3rd for private use, 1/3rd for income-earning use and 1/3rd for capital use. The plane is unused for the remainder of the year.

The following expenditure is incurred in relation to the plane:

  • $100,000 solely relating to private use (for example, fuel and pilot costs directly attributable to private use);
  • $100,000 solely relating to income-earning use (for example, fuel and pilot costs directly attributable to income-earning use);
  • $100,000 solely relating to capital use (for example, fuel and pilot costs directly attributable to capital use); and
  • $100,000 "mixed-use" expenditure that does not solely relate to any specific use (for example, the annual insurance premium for the plane).

In relation to the non-mixed-use expenditure, the $100,000 solely relating to the income-earning use should be fully deductible (as per section DG 7(1)) and the $200,000 that solely relates to private and capital use should be non-deductible (as per the private and capital limitations in section DA 2).

Mixed-use expenditure of $33,000 that is considered to relate to income-earning use should be deductible under subpart DG. To ensure that this is the result under the mixed-use asset rules, the definition of the "expenditure" item in section DG 9(3)(a) has been amended to ensure the full $100,000 of mixed-use expenditure is included in this item. This requires there to be no apportionment under the capital limitation and the private limitation before the application of the apportionment formula in section DG 9(2):

Expenditure (that is, all mixed-use expenditure) x (Income-earning days ÷ (Income-earning days + counted days))

$100,000 x (20÷60)  =  $33,000

Definitions of "asset income"

If a taxpayer generates assessable income from a mixed-use asset in an income year of less than 2 percent of the asset's value, some of the deductions generated by the asset are quarantined until a future income year. The low relative level of income generated by the use of the asset suggests that the asset is likely to be a predominantly private asset and therefore it is appropriate to suspend tax deductions that could otherwise be used to offset the taxpayer's income from other sources.

If the income does not reach the 2 percent threshold, any deductions above the assessable income from the asset (the "asset income") derived in that income year are quarantined, to be accessed in future income years. The effect is that, in a year when a taxpayer derives a relatively low level of assessable income from the asset, the taxpayer is allowed deductions sufficient to offset that assessable income (so no tax is payable in respect of the income from the asset), but is not able to access other deductions for that asset.

In a future income year, the taxpayer is able to access quarantined deductions if they have income from the use of the asset that exceeds their current year deductions. The amount of quarantined expenditure that can be accessed by the taxpayer is the lesser of the quarantined expenditure and the excess of current year income from the asset (the "asset income") above current year allowable deductions.

An amendment to the definition of "asset income" in the provision that allows taxpayers to access quarantined expenditure (section DG 17) has aligned this definition with the definition of the same term in section DG 16.

In the primary quarantining provision (section DG 16), the "asset income" is the total amount of income, other than an amount of exempt income, derived for the income year from the use of the asset. This is the correct approach as taxpayers should not be able to access excess deductions because they have earned exempt income, as they do not need the deductions to offset against the exempt income.

In contrast, before the amendment to section DG 17, "asset income" was the total amount of income derived for the current year from the use of the asset. There was no exclusion for exempt income. This means that taxpayers could have accessed excess quarantined deductions on the basis of exempt income they derive in relation to the asset (for example, income from associates, which can be easily manipulated). Given the income is exempt, accessing quarantined deductions in this way would also have given rise to a net loss on the asset for that income year which is contrary to the policy intention of the provision.

Accordingly, the definition of "asset income" in section DG 17 has been aligned with the definition of the same term in section DG 16, that is, for both sections "asset income" is the total amount of income, other than an amount of exempt income, derived for the income year from the use of the asset.

Application dates

The amendments to the mixed-use asset associated persons rule and the legislative examples apply for the 2013-14 and later income years (the beginning of the mixed-use asset regime).

The amendment to the depreciation rollover relief provision applies generally for the 2013-14 and later income years. However, the amendment does not apply in relation to an asset when a shareholder who acquires the asset disposes of it before 22 November 2013 (the date of the introduction of the Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Bill).

The amendment to address the potential overvaluation of land and improvements for the purposes of the mixed-use asset rules applies for the 2013-14 and later income years.

The amendment to address capital use of an asset applies for the 2013-14 and later income years for land and improvements, and for the 2014-15 and later income years for aircraft and boats.

The amendment to align the "asset income" definition in section DG 17 with that in section DG 16 applies for the 2013-14 and later income years for land and improvements, and for the 2014-15 and later income years for aircraft and boats.

Loss grouping contingent on group loss company satisfying its liabilities for deductible expenditure

Sections CG 2, CG 2C, CG 2D, CG 2E and FM 5(3), (4) of the Income Tax Act 2007

The loss grouping rules have been amended to correct an unintended consequence arising during the rewrite of the Income Tax Acts. The amendments confirm the benefit of past loss grouping is contingent on the group loss company satisfying its liabilities relating to past deductible expenditure (other than under the financial arrangement rules).

Consequential amendments have also been made to clarify the relationship of new sections CG 2C to CG 2E with the consolidated group rules in subpart FM, the amalgamation rules in subpart FO, and the loss grouping rules in sections IC 11 and IC 12.

Background

Since enactment of section 191(7B) of the Income Tax Act 1976, the grouping of tax losses has been contingent on the group loss company fully satisfying its liabilities for deductible expenditure included in its tax losses made available to another company under the loss grouping rules. Section 191(7B) was re-enacted into the Income Tax Act 1994 as sections CE 4, IE 1(4) and IG 2(9).

These provisions permitted the Commissioner to amend an assessment of a group profit company to reduce the amount of grouped tax losses to the extent the group loss company had not satisfied all liabilities giving rise to deductions included in the grouped tax losses. This amendment could be made for any income year as the time bar did not apply.

The rewrite of these provisions included a policy change (in section CG 2 of the 2004 Act), that changed the timing of the adjustment for remitted or cancelled debts for past deductible expenditure. This policy change was to better align the adjustment (for remitted or cancelled liabilities relating to past deductible expenditure) with self-assessment by eliminating the need to amend past assessments.

Under current section CG 2, a remitted or cancelled debt for past deductible expenditure is treated as income derived in the year the debt is remitted (for example, on the company being struck off or liquidated). However, section CG 2 does not provide that the benefit of loss grouping is contingent upon the group loss company fully satisfying its liabilities for past deductible expenditure incurred in years in which tax losses were grouped. The amendments correct this anomaly in the law.

Key features

Section CG 2 no longer applies to a group loss company if:

  • the group loss company has previously made a tax loss available to another company in the same group of companies under the loss grouping rules; and
  • the group loss company in the same group of companies as the group profit company has unsatisfied liabilities for deductible expenditure included in those past tax losses made available under the loss grouping rules; and
  • the group loss company in the same group of companies is removed from the register of companies; or
  • either the group profit company or the group loss company has left the group and for both cases, the group loss company is insolvent, in receivership or in liquidation at that time.

Instead, new sections CG 2C and CG 2D apply, as appropriate, to these circumstances. These amendments restore to the law, the long-standing policy that the benefit of grouped tax losses is contingent on the group loss company fully satisfying its liabilities relating to past deductible expenditure incurred in the year the losses are grouped.

Under sections CG 2C or CG 2D, the group profit company derives income equal to the amount of certain unsatisfied liabilities of the group loss company.

New section CG 2C will apply if the group loss company has been removed from the register of companies.

New section CG 2D will apply if the profit company and the group loss company break their grouping status.

New section CG 2E permits the company deriving income under either section CG 2C or CG 2D to apportion the income appropriately among certain group companies.

Amendments to section FM 5 clarify how sections CG 2C and CG 2D are to apply to a consolidated group of companies.

An amendment to section FO 5 ensures that neither of sections CG 2C or section CG 2D apply on an amalgamation. However, to ensure an amalgamation cannot be used to avoid the effect of section CG 2C or CG 2D, the amalgamated company is treated as if it were the group loss company after amalgamation in relation to relevant unpaid liabilities of the group loss company.

Sections IC 11 and IC 12 (relating to loss grouping) apply before section CG 2C or section CG 2D apply.

Application date

New sections CG 2C, CG 2D, and CG 2E, and consequential amendments to sections FM 5 and FO 5 apply from 22 November 2013, the date the Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Bill was introduced.

Detailed analysis

Reduction in benefit of group tax losses under the Income Tax Act 1994

The interaction of sections IG 2(9), IE 1(4) and CE 4 of the Income Tax Act 1994 permitted the Commissioner to amend an assessment of a group profit company to reduce the amount of losses made available under the loss grouping rules. This amended assessment of a group profit company could be made for any income year - it was not limited by the four-year time bar that normally applies to income tax assessments. However, the reduction in the benefit of grouped tax losses was limited to the amount of remitted or cancelled debts of the group loss company.

In the decision of Hotdip Galvanisers (Christchurch) Ltd v CIR (1999) 19 NZTC 15,337, the Court of Appeal confirmed that, under the 1976 Act's corresponding provision to section IG 2(9) of the 1994 Act:

  • the Commissioner was entitled to amend an assessment of a group profit company in a group that received the benefit of tax losses from a group loss company, if the group loss company's deductible expenditure forming part of the loss offsets was remitted or cancelled;
  • the provision did not require the Commissioner to first re-assess the group loss company for the remission adjustment; and
  • the Commissioner was not limited by the four-year time bar that normally applies to income tax assessments.

Policy change in Income Tax Act 2004

In rewriting sections CE 4 and IE 1(4)(d) of the Income Tax Act 1994 into section CG 2 of the Income Tax 2004, it was considered desirable to place the timing of the effect of the remission on a basis consistent with self-assessment. This policy change resulted in timing the effect of the adjustment for the remitted or cancelled debts to the year of remission or cancellation in contrast to the amendment of previous years' assessments under the former law.

Unintended consequence

Section CG 2 applies only to the taxpayer that had incurred the debt, and does not apply to a group profit company if a group loss company cannot be assessed for section CG 2 income (a company that is removed from the register of companies cannot be assessed for remission income). Consequently, no legislative provision exists to reduce the benefit of past grouped tax losses from group profit companies if debts of the group loss company are remitted or cancelled, in contrast to the situation under the 1994 Act.

New sections CG 2C and CG 2D correct this anomaly in the law and ensure that the benefit of past loss grouping is contingent on the group loss company:

  • fully satisfying its liabilities for deductible expenditure included in a net loss (other than expenditure relating to a financial arrangement rules); and
  • that net loss has been included in a tax loss subsequently made available under the loss grouping rules to another company in the same group of companies.

Group loss company removed from the register of companies

Section CG 2C applies to a group profit company in a group of companies if:

  • the group profit company has received the benefit of tax losses under the loss grouping rules from a group loss company in the same group of companies;
  • the group loss company is removed from the register of companies (and not subsequently restored to the register);
  • the group profit company and the group loss company are in the same group of companies immediately prior to the removal of the group loss company from the register of companies;
  • at the time the company is removed from the register of companies, the group loss company has unsatisfied liabilities for past deductible expenditure relating to tax losses made available to the group profit company under the loss grouping rules; and
  • the removal of the group loss company from the register of companies occurs after the tax loss has been made available to another company under the loss grouping rules.

On removal from the register of companies, there is no longer a company in existence to meet those unpaid unsatisfied debts or be assessed for income under section CG 2. New section CG 2C section treats the group profit company as deriving income equal to the remitted or cancelled liability for deductible expenditure incurred by the group loss company.

New section CG 2C applies if the group loss company and the group profit company are in the same group of companies immediately before the group loss company is removed from the register of companies. If grouping status is broken, section CG 2D applies.

The income is treated as derived on the day the group loss company is removed from the register of companies.

New section CG 2C will not apply to an expenditure relating to the financial arrangement rules.

Group loss company or group profit company leaving the group

A number of commercial considerations mitigate against section CG 2C applying to a group profit company when grouping status is broken with a group loss company.

These considerations include the following:

  • At the time the group loss company is removed from the register of companies, the management decisions relating to the group loss company would made by a different management team from that managing the affairs of the group profit company. A decision to remove the group loss company from the register of companies by the new owners need not consider the implications for that group profit company given they are no longer part of the same group of companies.
  • A tax obligation for a company arising from the liquidation of a group loss company that is no longer part of the same group as the group profit company (and beyond the management of the group's affairs) can impact adversely on the group profit company's balance sheet.
  • The tax obligation can potentially affect existing financing arrangements.

When a company exits the group, it can be assumed that management would be aware of the following facts at that time:

  • if an insolvent group loss company has not satisfied its debts giving rise to tax losses transferred under the loss grouping rules;
  • if the exiting company has received the benefit of tax losses from that insolvent group loss company;
  • if the exiting company is the insolvent group loss company; and
  • there is a risk that the insolvent loss group company might not subsequently satisfy its debt obligations for past deductible expenditure incurred in years in which past tax losses were made available under the loss grouping rules.

Under new section CG 2D, the benefit of past grouped tax losses is adjusted to the profit company, to the extent the insolvent loss group company has unsatisfied liabilities for past deductible expenditure in years in which losses were grouped. However, if the group loss company satisfies its unpaid debts for past deductible expenditure before the exit time, without giving a preference to one creditor over another, section CG 2D would not apply.

New section CG 2D will not apply to an expenditure relating to a financial arrangement.

Voidable transaction

Because solvency is measured at a point in time, an issue arises under the voidable transaction rule in the Companies Act 1993.

It is possible for a payment by the group loss company to satisfy an unpaid liability for past deductible expenditure to be a voidable transaction under the Companies Act 1993. If the payment is a voidable transaction (a creditor is repaid in preference to other creditors), a liquidator could subsequently recover the payment from the creditor, resulting in the relevant liability being reinstated.

The Commissioner has discretion, at the time grouping is broken, to determine whether a transaction to satisfy relevant unpaid liabilities could be a voidable transaction under the Companies Act 1993. If the Commissioner exercises this discretion, for the purpose of section CG 2D only, transactions relating to the funding and payment of such a transaction can be ignored in determining whether the group loss company is solvent.

Section IC 11 and IC 12

Section IC 11 permits the Commissioner to amend an assessment of a group profit company to reduce the tax loss of a group loss company made available to it for a tax year if the Commissioner has reduced the available tax loss of the group loss company for that year. This section applies, for example, when the group loss company has taken a tax position on the deductibility of an expenditure that has not been accepted by the Commissioner.

Section IC 12 ensures that deductions of a group loss company relating to inter-company bad debts or decline in the value of shares in a group company are not available for grouping.

Sections IC 11 and IC 12 are applied before sections CG 2C or CG 2D are applied.

Remitted amounts on discharge from bankruptcy

Sections CG 2 and CG 2B of the Income Tax Act 2007

Section CG will no longer apply to a bankrupt on discharge from bankruptcy, as it conflicts with the "fresh start" principles of insolvency law on discharge from bankruptcy. Section CG 2 applies to treat an amount of income equal to the amount of remitted or cancelled debts that were incurred for past deductible expenditure.

Instead, section CG 2B now applies to a person discharged from bankruptcy. This new section provides that a discharged bankrupt will derive remission income to offset against any tax losses the person has. However the amount of the income is limited to the lesser of the following:

  • the total amount of debt remitted on discharge from bankruptcy that relates to past deductible expenditure; and
  • the bankrupt's loss balance at the end of the tax year preceding the discharge from bankruptcy after taking into account any reduction in the loss balance made by the Commissioner under section 177C of the Tax Administration Act 1994.

Background

On 3 October 2011, the Minister of Revenue issued a press release calling for submissions on remedial items, including one relating to the Commissioner's powers, under section 177C of the Tax Administration Act 1994. Under section 177C, the Commissioner may:

  • write off uncollectible amounts of tax owing by the bankrupt; and
  • make consequential adjustments to the taxpayer's tax losses carried forward (the loss balance).

Submissions raised two issues relating to the remission of most debts when a bankrupt is discharged from bankruptcy:

  • Insolvency law remits most debts of a bankrupt at the time of discharge. One issue was whether it was appropriate for section CG 2 to recover all of the past deductions (as remission income of the taxpayer) if debts incurred for those past deductions:
    • remained unpaid on the taxpayer being adjudged bankrupt; and
    • were subsequently remitted on discharge from bankruptcy.
  • It was unclear whether remission income under section CG 2 was taken into account in the calculation of the bankrupt's taxable income before or after being discharged from bankruptcy. This uncertainty potentially impacted on the Commissioner's powers to write off tax and adjust a loss balance of the bankrupt.

Application date

The amendment applies to a discharge from bankruptcy that occurs on or after 1 April 2014.

Detailed analysis

Section CG 2 applies to a person:

  • who has been allowed a deduction for an amount the person is liable to pay;
  • that liability is later remitted or cancelled (but not if the remission or cancellation is a dividend); and
  • the financial arrangement rules do not require a base price adjustment to be made for that remission or cancellation.

Effect of law under the Income Tax Act 1994

Before enactment of the Income Tax Act 2004, a debt remission in the course of bankruptcy would have resulted in the Commissioner amending the income tax assessment for the tax year if the debt was incurred for a deductible expenditure (section CE 4 of the Income Tax Act 1994).

This amended assessment was not limited by the four-year time-bar that normally applies to the amendment of income tax assessments. However, the amount of the amended assessment to reduce past tax losses was limited to the amount of remitted or cancelled debts of the bankrupt. This amended assessment would have resulted in either:

  • a reduction in the person's loss balance at the end of that earlier tax year; or
  • an increased income tax liability being assessed for that earlier tax year.

Policy change in Income Tax Act 2004

In rewriting section CE 4 of the Income Tax Act 1994 as section CG 2 of the Income Tax 2004, it was considered desirable to place the timing of the effect of the remission on a basis consistent with self-assessment. This change was to the timing of the adjustment for the debt remission, that is, the adjustment would be made in the year of remission rather than amending prior years' assessments to make that adjustment.

However, this change in the timing has left it unclear whether the bankrupt would have income under section CG 2 on discharge from bankruptcy.

Amendment to section CG 2, new section CG 2B

The potential application of section CG 2 to a bankrupt on discharge from bankruptcy conflicts with the "fresh start" policy of insolvency law for a discharged bankrupt. The amendments ensure that section CG 2 does not apply on discharge from bankruptcy. Instead, the new section CG 2B applies to a person discharged from bankruptcy.

If a person discharged from bankruptcy has a loss balance at the end of the tax year preceding the year in which the discharge occurs, the person has income equal to the lesser of:

  • the total amount of debts remitted which relate to past deductions; and
  • the person's loss balance at the end of the tax year preceding the year of discharge (after taking into account any reduction in that loss balance by the Commissioner under section 177C of the Tax Administration Act 1994).

Income derived under section CG 2B is treated as derived on the first day of the income year in which the person is discharged from bankruptcy. This income is included in the calculation of the person's taxable income for the year of discharge and:

  • effectively reduces the benefit of the loss balance of the taxpayer brought forward from the previous year; and
  • ensures that a discharged bankrupt does not have an income tax liability for debts discharged in bankruptcy.

If a person discharged from bankruptcy does not have a loss balance at the end of the tax year preceding the year in which the discharge occurs, that person will not have remission income under either of sections CG 2 or CG 2B.

Serious hardship

Sections 176 to 177C of the Tax Administration Act 1994

Amendments have been made to allow the Commissioner, in appropriate circumstances, to bankrupt taxpayers, who are in serious hardship and to ensure the reasons why the debt arose are not a factor in determining whether the taxpayer is in serious hardship. These amendments ensure that the legislation is consistent with Inland Revenue's operational practice.

Background

In 2003, the debt and hardship rules were introduced. Under the rules the Commissioner must maximise the recovery of outstanding tax from a taxpayer and deal with cases in an efficient manner. However, the Commissioner may not recover to the extent that recovery is an inefficient use of the Commissioner's resources or if it would place a taxpayer, who is a natural person (individual), in serious hardship.

The rules provide incentives for taxpayers who are having problems paying their tax to contact Inland Revenue and discuss the payment options available to them. The best option is always payment of the full amount on or before the due date. If that is not possible, taxpayers can enter an instalment arrangement and pay the debt off over time. If the debt cannot be paid off over time, the Commissioner has a discretion under which she can write off tax. In addition, the Commissioner must write off the tax that is not collected if the taxpayer is bankrupted, liquidated or their estate has been distributed. The Commissioner's practice is to bankrupt taxpayers who cannot pay in appropriate circumstances, for example, when it is considered the write-off would have an adverse effect on taxpayers' perceptions of the integrity of the tax system.

Following a review of the legislation, an alternative view of the rules was raised which had two related implications.

The first implication was that bankruptcy is a recovery action and at the point that any further recovery action would cause serious hardship, bankruptcy, along with any other recovery action, was prohibited. Therefore, the Commissioner could not bankrupt a taxpayer when the taxpayer was facing serious hardship.

Inland Revenue's view is that bankruptcy does not necessarily place or cause a taxpayer to be in serious hardship. This is consistent with the policy intent; the Official Assignee takes over the bankrupt's affairs and ensures they do not suffer serious hardship.

The second implication arose from the alternative view that in determining whether a taxpayer is in serious hardship, Inland Revenue needed first to consider how the debt arose. For example, if the taxpayer's debt arose from the taxpayer enjoying goods of an expensive nature, the taxpayer would not be in serious hardship and Inland Revenue could recover the debt.

This view was at odds with the way Inland Revenue applies the debt and hardship rules and could result in adverse outcomes for taxpayers. The view was also inconsistent with the policy intention of the rules which is to protect taxpayers from being placed in serious hardship as a result of recovery actions taken by Inland Revenue.

Inland Revenue's approach is that when a taxpayer applies for financial relief, Inland Revenue determines whether the taxpayer can pay the debt, or whether paying part or all of the debt would place the taxpayer in serious hardship. The cause of the outstanding tax is not taken into account in determining serious hardship as the alternative view would have required. If paying the debt would place the taxpayer in serious hardship, Inland Revenue then considers how best to deal with the debt, and in some cases writes off the debt. In some cases the taxpayer would be bankrupted and in other cases the debt would remain. In deciding which action to take, Inland Revenue will, at this stage, consider how the debt arose and the need to maintain the integrity of the tax system.

Key features

The Tax Administration Act 1994 has clarified the meaning of "serious hardship" and it has been made clear that the factors that give rise to the taxpayer not being able to pay the outstanding tax are not taken into account when determining whether or not the taxpayer is in serious hardship.

It has also been clarified that the Commissioner of Inland Revenue can, in appropriate circumstances, bankrupt taxpayers, when they are in serious hardship.

Application date

The amendments apply from 30 June 2014, being the date of enactment.

Unacceptable tax position

Section 141B of the Tax Administration Act 1994

An amendment to the unacceptable tax position penalty clarifies that the penalty does not apply to shortfalls that arise in respect of GST and withholding-type taxes. That is, the unacceptable tax position penalty only applies to income tax shortfalls. The amendment clarifies an amendment made in 2007.

Background

A tax shortfall is the difference between a taxpayer's correct tax liability calculated under the legislation and the position a taxpayer took in their tax return. There are five categories of shortfall penalty - ranging from not taking reasonable care (when the penalty is 20 percent of the tax shortfall) to evasion or a similar act (when the penalty is 150 percent of the tax shortfall). The appropriate penalty is assessed when a required standard is breached, for example, if the taxpayer does not take reasonable care, the penalty for not taking reasonable care is assessed.

One of the shortfall penalties is the unacceptable tax position penalty. An "unacceptable tax position" is a tax position that, if viewed objectively, fails to meet the standard of being "about as likely as not to be correct". This does not mean that the taxpayer's tax position must be the better view or be more than likely the correct view, but rather that the position is "about as likely as not to be correct".

The aim of the shortfall penalty is to encourage taxpayers to take tax positions that are correct in terms of the law. A taxpayer is liable to pay a shortfall penalty of 20 percent if the taxpayer takes an unacceptable tax position in relation to income tax, and the tax shortfall arising from the taxpayer's tax position is more than both:

  • $50,000; and
  • 1 percent of the taxpayer's total tax figure for the relevant return period.

A change to the legislation in 2003 meant the unacceptable tax position penalty potentially applied to all tax shortfalls over the thresholds, including cases when the tax shortfall arose from a mistake in the facts or when an unacceptable tax position was taken and immediately corrected. Taxpayers and tax agents noted that the penalty was having an adverse effect on taxpayer behaviour, resulting in taxpayers being less inclined to make voluntary disclosures. In 2006 a short-term solution was put in place which gave Inland Revenue a discretion not to impose the penalty in specific circumstances.

In 2007 the discretion was repealed, the threshold for imposition of the penalty was increased and the scope of the penalty was limited to income tax, that is, the penalty was no longer to be imposed on GST or withholding tax shortfalls. At the same time, the reduction given for voluntary disclosures made before a taxpayer is notified of a pending audit or investigation when the shortfall arose from the taxpayer not taking reasonable care, or from an unacceptable tax position, increased from 75 percent to 100 percent.

Following a review of the legislation, it was determined that the 2007 amendment did not achieve the desired policy outcome. The 2007 amendment inserted the words "in relation to income tax" in section 141B of the Tax Administration Act 1994. However, section RA 2 of the Income Tax Act 2007 deems the tax types listed in section RA 1 to be "income tax" and therefore were subject to the unacceptable tax position penalty. These taxes include PAYE, fringe benefit tax and non-resident withholding tax.

The intention of the 2007 amendment was clear and taxpayers expected that following the amendment the unacceptable tax position penalty would only apply to tax shortfalls that arose in annual income tax returns. Inland Revenue's practice was to apply the penalty only to tax shortfalls that arise in annual income tax returns.

Key features

The amendment clarifies that the tax types listed in section RA 1 of the Income Tax 2007 have been removed from the scope of the unacceptable tax position shortfall penalty so that the penalty applies only to tax positions relating to income tax.

Application date

The amendment applies retrospectively to tax positions taken on or after 1 April 2008 (the application date of the 2007 amendment).

Clarification of new due date for payment of tax

Section 142A of the Tax Administration Act 1994

Amendments clarify that a new due date is not set when the Commissioner makes a systems-generated default assessment, and that when a taxpayer files a return following a systems-generated default assessment, a new due date is set for the resulting tax liability.

Background

If the Commissioner makes an assessment or amends and increases an assessment, a new due date is set for the tax assessed. Before an amendment in 2007, a new due date was only required when the Commissioner increased an assessment. This had the effect of creating an incentive for taxpayers who considered they did not have a tax liability to file a "nil return". This meant that if the Commissioner determined at a later date that the taxpayer did have a tax liability, a new due date would be set for the tax assessed by the Commissioner. In the absence of the "nil return", the taxpayer would be liable for use-of-money interest and late payment penalties from the original due date and, when the taxpayer had breached a required standard of behaviour, shortfall penalties.

There was a concern that the penalty rules were discouraging taxpayers from complying voluntarily with their tax obligations, as the imposition of both use-of-money interest and late payment penalties overly penalised taxpayers. Also, the application of late payment penalties when the taxpayer considered they did not have a tax liability could be seen as inappropriate. In some cases the late payment penalty was effectively being used as a penalty for the taxpayer not filing their return on time.

In 2007 an amendment was made under which Inland Revenue is required to set a new due date when it makes an assessment or increases an assessment. In 2009 the provision was again amended. The aim of this amendment was to remove the requirement to set a new due date when Inland Revenue makes a systems-generated default assessment.

More recently, concerns were raised that the 2009 amendment did not achieve the desired policy outcome. In particular, it was found that when a taxpayer files a return following a default assessment, a new due date would only be set when the tax assessed by the taxpayer is more than the default assessment and the new due date only applied to the difference.

This was contrary to the policy intent which is that the late payment penalty is a penalty imposed when the taxpayer knows they have a tax liability and they do not pay on time. Default assessments are made by the Commissioner under section 106 of the Tax Administration Act 1994. There are a number of different circumstances when the Commissioner can issue a default assessment, for example, when a return has not been made or following an audit or investigation when the Commissioner is not satisfied with the return filed by the taxpayer.

The 2009 amendment which removed the requirement to set a new due date when Inland Revenue makes a default assessment was aimed at systems-generated default assessments, assessments generated by Inland Revenue's FIRST system to encourage the taxpayer to file an outstanding return. It was not aimed at assessments made by the Commissioner following an audit. It was considered appropriate to impose late payment penalties from the original due date because, in the case of systems-generated default assessments, the assessment is issued because there is a concern about the taxpayer's non-compliance.

Key features

Section 142A of the Tax Administration Act 1994 has been clarified to ensure that a new due date is not set when the Commissioner makes a systems-generated default assessment. It has also be clarified that when a taxpayer files a return following a systems-generated default assessment, a new due date is set for the resulting tax liability.

Application date

The amendment will apply retrospectively from 6 October 2009 (which was the application date of the 2009 amendment).

References to loss attributing qualifying companies

Sections 141EB and 141FD of the Tax Administration Act 1994

In 2010 the loss attributing qualifying company rules were repealed and the look-through company rules introduced. The promoter penalty legislation still referred to "loss attributing qualifying companies" when it should have referred to "look-through companies".

The amendment updates references in the promoter (section 141EB) penalty legislation that referred to loss attributing qualifying companies so they now refer to look-through companies. The penalty relief provision for loss attributing qualifying companies has also been repealed.

Application date

The amendments apply from 1 April 2011 (the date from which the look-through company rules apply).

Working for Families Tax Credits

Sections MB 1(5C), 7B(2) and 13(2) of the Income Tax Act 2007

Amendments have been made to clarify that various payments that are of a capital nature, or are windfall gains, are excluded from the definition of "family scheme income" in section MB 13 of the Income Tax Act 2007. These include repayments of mistaken or misdirected payments, refunds, a capital payment from a person's ownership in a business, inheritances and lottery winnings.

Background

Working for Families tax credits are provided to the principal caregiver of dependent children based, among other things, on their level of family scheme income for a tax year. The tax credits are abated when family scheme income exceeds $36,350 at a rate of 21.25 cents per dollar. Families that choose instalment payments of tax credits throughout the year are required to estimate their family scheme income and are subject to an end-of-year reconciliation. Alternatively, families can apply for an end-of-year lump sum payment.

The family scheme income provisions have been amended several times over the last decade, including as part of the rewrite of the Income Tax Act. The definition of "family scheme income" was broadened as part of Budget 2010, with effect from 1 April 2011. This included a new provision for other payments a family may receive to replace lost income or to meet their usual living expenses. The broader definition is intended to improve the fairness and integrity of Working for Families tax credits by, for example, countering arrangements that have the effect of inflating entitlements beyond what people's true economic circumstances justify.

In 2012 the Government agreed that employer-provided vouchers and other short-term charge facilities should also be included in family scheme income. This change came into effect from 1 April 2014.

The definition of "family scheme income" is also used, with some adjustments, for determining eligibility for some people applying for student allowances and the community services card. A similar definition is used for student loan repayments.

Key features

Changes to the rules in subpart MB of the Income Tax Act 2007 describing the definition of "family scheme income" have been made. The main change adds the following items to the list of payments that are excluded from the "other payments" rule in section MB 13:

  • repayment of a loan;
  • repayment of a mistaken or misdirected payment;
  • refund of a payment (including tax, student loan and child support refunds resulting from an overpayment);
  • payment from the person's ownership of an investment activity or business, where it is received on capital account, and the payment is not a loan and is not a payment by a trustee;
  • payment of an inheritance from a deceased person's estate;
  • money won from gambling or a New Zealand lottery.

The other changes in subpart MB:

  • correct a cross-reference error in section MB 1(5C);
  • amend section MB 1(5C) to cover depreciation loss for a building in an investment activity, to mirror earlier changes made to section MB 3 to ignore net losses from investment activities; and
  • correct a drafting error in section MB 7B(2)(b) to refer to a "benefit" instead of a "fringe benefit".

Application dates

The amendments to section MB 13(2) apply for the 2015-16 and later income years.

The amendments to section MB 1(5C) apply from 1 April 2011.

The amendments to section MB 7B(2) apply from 1 April 2014.

Detailed analysis

Current sections MB 1 to MB 12 list specific amounts that are included in family scheme income. Section MB 13(1) includes other payments in the definition of family scheme income when the payment is paid or provided to the person from any source and used by the person to:

  • replace lost or diminished income of the person or the person's family; or
  • meet usual living expenses of the person or the person's family.

Section MB 13(2) excludes payments from section MB 13(1) when the payment is not intended to form part of family scheme income. An example is when a payment is already included in family scheme income under sections MB 1 to MB 12, or when it is paid or provided by the government and treated as exempt income for tax and welfare purposes.

The Working for Families tax credits are income-tested on family income. While it has a broad definition of income, it is not the policy intent for the tax credits to be asset-tested. For example, using money or cash assets from a person's bank account for usual living expenses is not intended to be included in family scheme income, whereas interest earned on savings is included. Similarly, the family scheme income definition is not intended to capture the realisation of assets into cash, other than the extent to which it is assessable income under the Income Tax Act 2007.

Section MB 13(2)(b) excludes a payment if it is the proceeds of the disposal of property and not assessable income of the person disposing of the property. This is intended to prevent, for example, the proceeds from the sale of a family car, when the proceeds are used to meet usual living expenses, from being included in family scheme income. The exception is when sales proceeds are assessable income for that person.

There are payments not covered by section MB 13(2)(b) but which are similar, or they relate to a change in how assets are held or realised, which should be excluded. It is also not the policy intention to include windfall gains in family scheme income, to the extent that they are not assessable income. For families who estimate their family scheme income upfront, it would not be possible to accurately estimate windfall gains, and could lead to end-of-year debts. It is also unlikely that the family would rely on windfall gains to meet the family's usual living expenses.

Section MB 13(2) has been amended to exclude items that can be technically caught by the wording of section MB 13(1) but do not come within the policy intent of that provision. They are:

  • repayment of a loan - this covers the repayment of the principal of the loan. Interest payable on the loan is assessable income and is already included in family scheme income under another provision;
  • repayment of a mistaken or misdirected payment - this is not additional money for the person or their family;
  • refund of a payment (including tax, student loan and child support refunds resulting from an overpayment);
  • payment of an inheritance from a deceased person's estate; and
  • money won from gambling or a New Zealand lottery - these windfall gains are not intended to be caught by the "other payments" rule.

The amendments also include in the list of excluded items:

  • a payment from the person's ownership of an investment activity or business, when it is received on capital account, and the payment is not a loan and is not a payment by a trustee.

Dividends, shareholder salary, interest, or rent from a business or investment activity are not received on capital account and are already included under other provisions in subpart MB. A payment from a person's investment or business received on capital account is equivalent to the withdrawal of funds from a savings account and should likewise not be included in family scheme income. The person and their family are not "better off" from receiving the payment; rather they are converting their assets into cash. Often the payment on capital account will be referred to as "drawings", although some drawings may be a loan or income that has been incorrectly labelled.

A loan from a business or investment to the person will be excluded under section MB 13(2)(a) if it is on the basis of ordinary commercial terms and conditions.

The following examples illustrate situations when drawings are not included in the definition of family scheme income under section MB 13(2).

Example 1  

In 2012 John invests $20,000 into his partnership to boost working capital. The partnership grows. In 2016, John withdraws $20,000 from the partnership into his family's joint bank account. He and the family use the money for normal day-to-day items. The $20,000 would not be included as family scheme income under section MB 13 as, while it was paid to John and used to meet the family's usual living expenses, it falls under the exemption for withdrawal of capital funds invested in a business - section MB 13(2)(bd).

 

Example 2  

Hayley owns a company and draws out an amount of money on capital account for living costs. The company derives a profit and income tax is paid. An imputed dividend is declared, from which Hayley repays/offsets the drawings. The taxable dividend is treated as family scheme income so the drawings are not included in the family scheme income because section MB 13(2)(p) would apply. (Note also that under section MB 4 any company income that would be attributed as family scheme income is reduced by the dividend.)

Child support

Sections 2, 9, 40, 44, 65, 81, 92, 98, 142, 179A of the Child Support Act 1991

Various remedial changes are made to the Child Support Act 1991 to clarify wording, correct errors, make further consequential changes and make small changes to simplify the child support scheme.

Background

Under the Child Support Amendment Act 2013 a number of changes were made concerning child support terms, for example, the "custodial parent" of the qualifying child is now referred to as the "receiving carer". The Child Support Amendment Act 2013 will also amend, from 1 April 2015, the way a formula assessment of child support is determined and make improvements to the operation of the child support scheme.

Key features

The Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Act 2014 makes the following remedial changes to the Child Support Act 1991 (as amended by the Child Support Amendment Act 2013):

  • the definition of "election period" in the interpretation section has been repealed as there is a new definition of "election period" in new section 40AA;
  • new section 9(1)(c) clarifies that a beneficiary is not required to apply for child support if they are already a receiving carer;
  • it is clarified that notices of election in new section 40(1) cannot be given after the end of the child support year to which the election relates;
  • the ordering of provisions in new section 44 relating to the end-of-year reconciliation of an estimate of income have been corrected to ensure the intended policy outcome is achieved;
  • consequential changes to section 65 have been made in light of the new rules for determining liable parents and receiving carers, and to prevent a voluntary agreement and a formula assessment for a child being in force simultaneously;
  • new section 92(3A) has been repealed as the provision is no longer required;
  • section 98 has been amended to align with new section 32 on the method for distributing the minimum annual amount of child support when there is more than one receiving carer;
  • a change ensures that a non-parent receiving carer who has been granted a social security benefit under the Social Security Act 1964 cannot waiver the right to collect child support from a liable parent; and
  • further consequential amendments have been made to reflect the changes in child support terminology.

Application date

The amendments will apply from 1 April 2015.

Associated persons and person with a power of appointment or removal

Section YB 11(2) of the Income Tax Act 2007

An amendment to the associated persons rules ensures that a person with a power of appointment or removal of a trustee will not be associated with the trustee under section YB 11 (Trustee and person with power of appointment or removal) if they are subject to the professional code of conduct and disciplinary processes of an approved organisation. This is a remedial amendment to ensure the provision operates as intended. Before the amendment, members of approved organisations could avail themselves of the exclusion, but non-members, who were still subject to the approved organisation's professional code of conduct and disciplinary processes, could not.

Background

Section YB 11(1) of the Income Tax Act 2007 prescribes that a trustee of a trust and a person with the power of appointment or removal of trustees in relation to the same trust are associated for tax purposes.

An exclusion to this associated persons test was enacted by the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013. This exclusion was intended to ensure that those who receive a power of appointment or removal of a trustee in their professional capacity are not associated with the trustee of the trust.

Among other requirements, the exemption applies to a person who is a "member of an approved organisation". To be an approved organisation, the organisation's natural person members must be subject to a professional code of conduct and to disciplinary processes in accordance with that code (among other requirements).

There were circumstances in which this exemption did not operate as intended.

Using New Zealand Institute of Chartered Accountants (NZICA) as an example of an approved organisation, chartered accountancy (CA) practices can have partners who are members of NZICA and partners who are not members. A partner in a CA practice who is not a member of NZICA is still subject to NZICA's code of ethics and disciplinary process because they are part of a member firm. However, because they are not a member of NZICA themselves, they were previously not covered by the exclusion in section YB 11(2).

This was contrary to the policy of the exclusion - to exclude from the association test those trustees acting in a professional capacity. The membership of a professional body is generally an appropriate test to achieve this policy intention as it ensures that the class of persons able to avail themselves of the exclusion is limited and a high standard has to be met before the exclusion is available. The members of professional bodies (such as the New Zealand Law Society and NZICA) are also the most likely trustees to be acting in a professional capacity. However, a non-member of NZICA working in a CA firm is just as likely as an NZICA member to be a trustee in their professional capacity and should not be treated any differently for the purpose of the associated persons test.

Key features

The exclusion in section YB 11(2) has been extended to include not only members of an approved organisation, but also persons who are subject to the approved organisation's code of ethics and disciplinary process (provided the other requirements of the exclusion in section YB 11(2) are also met).

Application dates

The remedial amendment has the same application date as the original exclusion in section YB 11(2), that is, it applies for the purposes of:

  1. provisions other than the land provisions, for the 2010-11 and later income years;
  2. the land provisions other than section CB 11, for land acquired on or after 6 October 2009; and
  3. section CB 11, for land on which improvements are begun on or after 6 October 2009.

Tax Administration Act 1994: Cross-references to sections 108 and 109

Sections 93(2)(b), 94(2)(b), (c), 95(2)(b), 97(3)(a), 97B(3)(a), 98(2)(a), 98B(3)(a), 99(2)(a), (b), 100(3)(b), 101(2)(a) and 101B(2)(a) of the Tax Administration Act 1994

Sections 93(2)(b), 94(2)(b), (c), 95(2)(b), 97(3)(a), 97B(3)(a), 98(2)(a), 98B(3)(a), 99(2)(a), (b), 100(3)(b), 101(2)(a) and 101B(2)(a) are being amended to correct a cross-referencing error within section 94(2)(b) noted in a recent court decision. The other provisions listed are consequentially amended for consistency.

Background

In a recent court decision,3 it was identified that section 99(2)(a), in seeking to cross-refer to section 108, used language that did not appear in section 108. The same cross-referencing problem arises in a number of provisions from section 93 to section 101B of the Tax Administration Act 1994.

Similar drafting issues arise from the use of the term "taxpayer" in a number of provisions from section 93 to section 101B of the Tax Administration Act 1994 that refer to section 109 of the Tax Administration Act 1994. This is because the term "taxpayer" no longer appears in section 109.

Application date

The amendments apply from 1 October 1996.

Detailed analysis

Section 99 of the Tax Administration Act 1994 enables the Commissioner to assess a person for RWT if the Commissioner considers that person has not paid the correct amount of RWT. Under the RWT rules, a person paying resident withholding income is required to withhold RWT and pay to the Commissioner the amount of RWT withheld on a periodic basis.

The reference in section 99(2) of the Tax Administration Act 1994 to section 108(1) of the Tax Administration Act 1994 is to ensure that the Commissioner cannot amend an earlier RWT assessment outside the time-bar period. Peters J's comments in the Vinelight decision highlight a technical problem that the time bar may not apply to RWT assessments. Peters J identified a remedial issue within section 99 of the Tax Administration Act 1994, concerning the relationship of section 99 to section 108 of the Tax Administration Act 1994. This finding was endorsed in the later Court of Appeal decision in the same case. In the High Court, Peters J stated:

  • There is an obvious difficulty with s 99(2)(a), because s 108(1) does not include the words "income tax for any year". [100]

The judge's comments in the Vinelight decision highlight a technical problem that the time bar may not apply to resident withholding tax (RWT) assessments. The words identified by Peters J, "income tax for any income year", were repealed in 1996 as part of the reforms of the disputes resolution legislation. Section 99 of the Tax Administration Act 1994 was not updated at that time to reflect the new wording in section 108(1).

Section 108(1) imposes a time limit (time bar) on the Commissioner's power to amend an earlier assessment of income tax. That time-bar period is four years after the end of the tax year in which the earlier assessment was made.

Section 109 of the Tax Administration Act 1994 provides that disputable decisions are treated as correct unless a challenge is lodged against that decision, but the provision no longer uses the word "taxpayer". Disputable decisions include assessments by the Commissioner and most decisions of the Commissioner in relation to the application of a tax law to a taxpayer's circumstances.

This drafting issue also arises from these provisions not being updated correctly in 1996 to reflect the amended wording in sections 109.

These amendments are solely to correct the cross-reference wording into either section 108 or section 109 and do not change the effect of the current law.

Disposal of certain shares by a PIE

Section CB 26 of the Income Tax Act 2007

Section CB 26 has been amended so that it does not apply in relation to dividends from a listed PIE.

By way of background, section CX 55 provides that gains arising from the sale of most Australian and New Zealand-listed shares are excluded income for PIEs and similar entities. However, section CB 26 deems a taxable dividend to arise when a share that satisfies the criteria of section CX 55 is sold after a dividend is declared but before the dividend is paid. This is to prevent a PIE turning a taxable dividend receipt into a non-taxable gain on sale.

These concerns do not arise for dividends received from listed PIEs as those dividends are not taxable in any event. There is no tax advantage in selling a share in a listed PIE after a dividend is declared but before it is paid. There is therefore no need for section CB 26 to apply to dividends from a listed PIE as the unimputed portion of such dividends are not taxable under section CX 56C.

Application date

The amendment applies from the beginning of the 2013-14 income year.

Trusts that are Local and Public Authorities

Sections CW 38 and CW 39 of the Income Tax Act 2007

Amendments to sections CW 38 and CW 39 clarify that an amount derived by a trustee for a local authority or a public authority constituted as a trust:

  • does not enjoy the exempt income status under sections CW 38 or CW 39 if that amount is retained and included in trustee income of the trustee; and
  • is exempt income if that amount is distributed to a beneficiary that itself is exempt from income tax in relation to that distribution.

Background

The Income Tax Act 2007 currently exempts from tax any amount derived by a local authority and a public authority other than "an amount received in trust". The exact meaning of these words is unclear and their interpretation has caused difficulty for taxpayers and Inland Revenue.

The policy is that this exemption should not extend to amounts that a local authority receives as a trustee. However, if the trustee receives an amount as trustee for a beneficiary which itself enjoys exempt income status, the trustee may take that exemption into account in meeting the trustee's income tax obligations for the beneficiary.

Application date

The amendment applies from 30 June 2014, being the date of enactment.

Detailed analysis

The amendments to sections CW 38 and CW 39 address questions raised with the Commissioner relating to the trustee's tax obligations for the beneficiary of a trust for which a local or public authority is the trustee.

The amendment clarifies, for the avoidance of doubt, that income derived by a local or public authority as trustee on the terms of a trust is to be treated as follows:

  • the exemption for income derived by a public authority or a public authority does not extend to income derived in the capacity as trustee that has not been distributed; and
  • the trustee may take into account an exemption from income of the beneficiary for determining the trustee's income tax obligations on that beneficiary income under other provisions of the 2007 Act.

1 Section 50 of the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013 amended section EW 8 of the Income Tax Act 2007 from 27 September 2012 unless a taxpayer had taken a tax position.

2 The date the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013 received Royal assent.

3 Vinelight Nominees Limited v CIR [2012] NZHC 3306 (HC); (2013) 26 NZTC 21-055, [2013] NZCA 655.